Inflation Expectations and the Transmission of Monetary Policy
John M. Roberts 1998-43

Abstract:&nbspNew Keynesian models with sticky prices and rational expectations
have a difficult time explaining why reducing inflation usually requires a
recession. An explanation for the costliness of reducing inflation is that
inflation expectations are less than perfectly rational. To explore this
possibility, I estimate the degree of nonrationality implicit in two survey
measures of inflation expectations. I find that the surveys reflect an
intermediate degree of rationality: Expectations are nether perfectly rational
nor as unsophisticated as simple autoregressive models would suggest. I also
find that a structural New Keynesian model with expectations formation based
on the survey results is able to match closely the empirical costs of reducing
inflation.